Background
Technical analysis refers to the method of evaluating securities through the study of past market data, primarily price and volume. The core theory behind this analysis is that historical trading activity and price changes of a security can be valuable indicators of the security’s future price movements.
Historical Context
The foundations of technical analysis can be traced back to the late 19th century with the Dow Theory, which was developed by Charles Dow and his colleagues. Over the years, numerous methodologies, tools, and charting techniques have evolved, contributing to the wide adoption of technical analysis as a popular investment approach.
Definitions and Concepts
Technical analysis involves the use of various tools such as moving averages, trendlines, and oscillators to identify patterns and trading signals. The theory rests on three main assumptions:
- The market discounts everything
- Price moves in trends
- History tends to repeat itself
Major Analytical Frameworks
Classical Economics
Classical economists didn’t traditionally incorporate technical analysis as the focus remained on fundamental aspects like production, labor, and capital.
Neoclassical Economics
Incorporating enhanced focus on equilibrium and market efficiency, neoclassical economists often overlooked technical analysis, deeming it unpredictable due to fully rational behaviors assumed in markets.
Keynesian Economics
While Keynesians emphasize market-influencing factors like government policy, some interpretations involve market sentiments aligning loosely with technical analysis principles, yet not concretely.
Marxian Economics
Marxian thought does not integrate technical analysis, as the framework is primarily concerned with the larger socioeconomic factors impacting capital and labor.
Institutional Economics
Technical analysis diverges significantly from institutional economics, which focuses on the role of institutions and norms in shaping economic outcomes, rather than price movements and market data.
Behavioral Economics
Behavioral economists see potential merit in some aspects of technical analysis, noting that human psychological biases and irrational behaviors might create price patterns detectable through technical tools.
Post-Keynesian Economics
Just as Keynesian analysis focuses more on macroeconomic factors, Post-Keynsian approaches also generally move away from micro price movement analytics that characterize technical analysis.
Austrian Economics
Austrian economists place more weight on qualitative assessments and individual actions rather than historical price trends, thus share less compatibility with technical analysis.
Development Economics
Development economics, with its focus on economic progress in developing countries and macro-level phenomena doesn’t rely heavily on technical analysis.
Monetarism
Monetarism emphasizes the roles of money supply and control over inflation, offering little integration with the predictive and chart-based facets of technical analysis.
Comparative Analysis
Proponents of technical analysis argue that it enables traders to identify lucrative opportunities from price movement patterns. Critics argue it lacks empirical support and that market efficiency renders it ineffective. Empirical analyses often find mixed results, suggesting any patterns discernible by technical analysis are neutralized by trading costs and market efficiency.
Case Studies
Significant case studies include analysis of stock market bubbles, exploring how speculative activities identified through technical tools preceded major economic downturns.
Suggested Books for Further Studies
- “Technical Analysis of the Financial Markets” by John Murphy
- “A Random Walk Down Wall Street” by Burton G. Malkiel
- “Technical Analysis Explained” by Martin J. Pring
Related Terms with Definitions
- Efficient Markets Hypothesis: A theory positing that at any given time, prices fully reflect all available information, thus making it impossible to consistently achieve higher returns without assuming additional risk.
- Chartists: Market practitioners who employ chart-based methodologies from technical analysis to guide their investment decisions.
- Moving Averages: A widely used indicator in technical analysis that smooths price data to create a single flowing line, traditionally used to identify trends.
